Report Suggests New Directions For Economic Analysis of Climate Change:Four Papers Explore Limitations of Current Models, and Future Possibilities

Washington, DC - The computer models used to analyze the potential effects of climate change policies do not capture key drivers of present and future economic prosperity or current climate science, according to a set of four papers issued by the Pew Center on Global Climate Change.

Computer models that integrate scientific and economic theories and reams of data have become essential tools in climate change policy discussions. These "integrated assessment" (IA) models can be useful for several reasons: they assess specific climate change policies, coordinate multiple issues in a systematic framework, and provide an analytical method for comparing climate policies to other, non-climate-related policies.

However, a great deal of IA analysis is based on questionable assumptions. For example, many models begin with the premise that consumers and firms always succeed in maximizing their "enlightened self-interest" and have complete information about current and future options. The papers released today offer critiques of the assumptions underlying most current IA, and suggest ways that new and improved models could provide greater insights into climate policies.

"All of our work on the economic analysis of climate change indicates that our current analytic tools are inadequate and need improvement," said Eileen Claussen, President of the Pew Center on Global Climate Change. "Despite the obvious need for economic modeling of climate change policies, the findings are often abused by some analysts claiming the 'holy grail' of modeling results. These four reports not only question this often-misplaced confidence, but also identify topics absent in nearly all economic models, such as climate 'surprises' and drivers of technological innovation. Consideration of these important factors could have major repercussions for any climate policy discussion."

Modeling Assumptions Oversimplify The "Real" World

The four papers, written by leading experts and issued together under the title "New Directions in the Economics and Integrated Assessment of Global Climate Change," examine four issues that have major implications for IA.

The first paper, by Alan Sanstad of Lawrence Berkeley National Laboratory, focuses on technological innovation and its treatment in IA models. Most models do not incorporate a realistic assessment of how market forces drive innovation. While innovation would clearly lower the costs of addressing climate change, many modelers focus on the opportunity cost of encouraging climate-friendly technology. The fear is that climate-related R&D will "crowd out" other kinds of R&D. Sanstad's paper shows that policies promoting climate-related R&D may simultaneously encourage, not discourage, R&D in other sectors.

The second paper, by Stephen DeCanio of the University of California, Santa Barbara, discusses how IA models tend to assume that firms focus only on, and are entirely successful in, maximizing profits. This often leads to misunderstandings about how firms innovate, and the kinds of trade-offs they must make between economic and environmental performance. DeCanio's work describes firms as "information networks" with multiple objectives, which leads to a more complete picture of how private-sector organizations innovate. Another finding with major significance for climate policy is that firms can make improvements in environmental performance without sacrificing overall profitability.

The third paper, by Richard Howarth of Dartmouth College, addresses how future generations are depicted in most IA models. Using the so-called "overlapping generations" approach - pioneered by Nobel Laureate Paul Samuelson and used widely in public finance modeling - Howarth compares the potential impacts of three policy regimes on the welfare of present and future generations. The analysis suggests that while rising greenhouse gas emissions are a factor in short-term economic welfare, climate stability can be viewed as an economic asset that would contribute strongly to the welfare of future generations. In other words, even if short-term environmental damages of climate change turn out to be moderate, Howarth finds that near-term emissions control is still consistent with maintaining long-term economic well-being.

In the fourth paper, Stephen Schneider of Stanford University and Starley Thompson of Complex Systems Research, Inc. provide a new model to explore the causes and consequences of one major type of "climate surprise" -- the possible collapse of the "conveyor belt" circulation of the North Atlantic Ocean. Climate "surprises" are the low-probability but high-consequence scenarios driving much of the international concern about climate change. Currently, most IA models assume the climate responds slowly and predictably. The authors conclude that IA models that ignore the possibility of climate surprises probably overestimate the capacity of human society to adapt and underestimate the optimal control rate for greenhouse gas emissions. The implication is that the full range of plausible climatic outcomes needs to become part of climate policy analysis.

Continuation of Economic Series

The four papers released today are the latest in the Pew Center's series of reports on the economics of climate change. "But whereas until now we have focused on what has been done with economic analysis in the past, we are now beginning to focus on what needs to be done in the future," said Claussen. "We must explore new tools and methods to improve our forecasts."

"The aim", Claussen said, "is to suggest several new directions in which IA can and should develop to better enable citizens and policy-makers to grapple with the challenges posed by climate change." For example:

IA models that more accurately portray innovation will help policy-makers answer such questions as whether the government should subsidize climate-friendly R&D, or how to phase in emission reductions to take maximal advantage of technological progress.

IA models that more realistically portray businesses will make it clear that the challenge for policy-makers is to find ways to encourage businesses to innovate in multiple dimensions to meet multiple objectives.

IA models that take into account the standpoint of future generations will enable policy-makers to explicitly consider the implications of policy for equity as well as efficiency. And,

IA models that can explore the causes and consequences of "climate surprises" will help policy-makers to understand the implications of speeding up or slowing down the rate of greenhouse gas build-up, which may turn out to be as important as the size of the build-up.

A complete copy of these and other Pew Center reports can be accessed from the Pew Center's web site, www.c2es.org.

About the Pew Center: The Pew Center was established in May 1998 by the Pew Charitable Trusts, one of the United States' largest philanthropies and an influential voice in efforts to improve the quality of the environment. The Pew Center is a nonprofit, non-partisan and independent organization dedicated to providing credible information, straight answers and innovative solutions in the effort to address global climate change. Eileen Claussen, the former U.S. Assistant Secretary of State for Oceans and International Environmental and Scientific Affairs, leads the Pew Center. The Pew Center includes the Business Environmental Leadership Council, a group of large, mostly Fortune 500 corporations all working with the Pew Center to address issues related to climate change. The companies do not contribute financially to the Pew Center; it is solely supported by contributions from charitable foundations.